CORPORATE FINANCE AND PROJECT FINANCE 2018

Dr. SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY

Lucknow

Faculty of Law

TITLE FOR PROJECT

[CORPORATE FINANCUNG AND VALUATION]

For

COURSE ON ‘CORPORATE FINANCE AND PROJECT FINANCE’

Submitted by

[SAMEEKSHA GUPTA]

[143070042]

Academic Session: 2017-18

Under the Guidance of

Mr. Shail Shakya

Asst. Prof. in Law & Faculty for “CORPORATE FINANCE AND PROJECT FINANCE”
Faculty of Law
Dr. Shakuntala Misra National Rehabilitation University

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ACKNOWLEDGEMENT
The completion of this Assignment could not have been possible without the participation and
assistance of so many people whose names may not all the be enumerated. Their contribution is
sincerely appreciated and gratefully acknowledged. However, I would like to express my deep
appreciation and indebtedness particularly to the following.
Assistant Prof. Mr. Shail Shakya for his endless support, kind and understanding spirit during making
of this assignment. To all relatives, friends and others who in one way or another shared their
support, either morally, financially and physically, thank you.
Above all, to the Great Almighty God, the author of knowledge and wisdom, for his countless love.
I thank you all.
Sameeksha Gupta
4th year Student
B.Com. LL.B(Hons.)

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Table of contents

1. Introduction……………………………………………………………………………….4
2. Methods of Corporate Valuation…………………………………………………………..5
3. Project finance……………………………………………………………………………..6
4. Methods of Project Financing……………………………………………………………...7
5. Debt and its characteristics………………………………………………………………..10
6. Conclusion ………………………………………………………………………………..13

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 CORPORATE FINANCE AND PROJECT FINANCE 2018

Introduction

Corporate finance is the area of finance dealing with the sources of funding and the capital
structure of corporations, the actions that managers take to increase the value of the firm to
the shareholders, and the tools and analysis used to allocate financial resources. The primary goal
of corporate finance is to maximize or increase shareholder value.[1] Although it is in principle
different from managerial finance which studies the financial management of all firms, rather
than corporations alone, the main concepts in the study of corporate finance are applicable to the
financial problems of all kinds of firms.

Correspondingly, corporate finance comprises two main sub-disciplines. Capital budgeting is

concerned with the setting of criteria about which value-adding projects should receive
investment funding, and whether to finance that investment with equity or debt capital. Working
capital management is the management of the company's monetary, funds that deal with the
short-term operating balance of current assets and current liabilities; the focus here is on
managing cash, inventories, and short-term borrowing and lending (such as the terms on credit
extended to customers).Corporate valuation answers the question of how much a company is
worth. There are standard ratios, tools and methods used by financial analysts to determine a
corporations’ worth and whether their stock is undervalued or overvalued. Knowing this is very
important when it comes to mergers, acquisition, financial stress and market instability.

How corporations choose to finance their investments might have a direct impact on firm value.
Firm value is determined by discounting all future cash flows with the weighted average cost of
capital, which makes it important to understand whether the weighted average cost of capital can
be minimized by selecting an optimal capital structure (i.e. mix of debt and equity financing). To
facilitate the discussion consider first the characteristics of debt and equity.

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Methods of Corporate Valuation

1. The Common Method

One of the most common ways to determine the value of a company is called the asset-based
method that uses the book value of a company’s equity. In other words, it determines the value
of the company’s assets minus its debts. Regardless of whether it’s tangible items, such as cash
and working capital, or intangible things, such as brand name and reputation, equity is the most
important factor. Equity is everything that a company possesses if they were to suddenly stop
doing business and making money.

Most accountants prefer to use the traditional balance sheet method. This is an excellent way to
quickly determine if a company has more cash on hand than their current market value. First,
accountants examine a company’s cash, equivalents and short-term investments. They divide the
total number by the number of outstanding shares to measure how much of the current share
price consists of just available cash. When it comes to buying a company primarily through cash,
this yields a variety of benefits for the new owners. For example, cash can quickly fund strategic
acquisitions, product research and development and the costs of acquiring successful executives
and business leaders.

2. Alternative Methods

Another popular accounting measure of value is a company’s current working capital compared
to its market capitalization. Working capital is defined as what remains after the current
liabilities are subtracted from its current assets. Working capital are funds that a company can
quickly access to conduct daily business transactions. Knowing the accurate amount of working
capital is essential for businesses that trade and invest. Alternatively, shareholder’s equity is an
accounting tool that encompasses a company’s liquid assets such as cash, property and retained
earnings1.

Shareholder’s equity is an overall measure of the liquidation potential a company has if all of
their tangible assets were sold. Shareholder equity helps accountants to value a company when
1
https://www.master-of-finance.org/faq/what-is-corporate-valuation/

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they want to establish the book value, which is official value of the accounting ledger. In order to
calculate the book value per share, accountants divide the shareholder’s equity by the number of
outstanding shares. Then, they divide the stock’s current price by the book value and find out the
price-to-book ratio.

3. Free Cash Flows

Although most investors don’t understand the principles of cash flow, it is one of the most
common measurement tools for valuing public and private companies in the field of investment
banking. Cash flow refers to the money that passes through a company minus all fixed expenses
during the course of a period of time, such as a quarter or the year. Cash flow is officially
defined as the company’s earnings before interest, taxes, depreciation and amortization. Cash
flow focuses on the business operations and not on secondary costs or profits. To illustrate, taxes
depend on the current taxation regulations in a given year and can dramatically fluctuate2.

When it comes to corporate valuation, keep in mind that intangible assets like goodwill and
brand loyalty have value, but they cannot be quantified.

Project finance:

Project Finance is one of the key focus areas in today’s world because of continuous growth and
expansion of the industries at a rapid rate. Project finance is a centuries-old form of financing
high-risk, development-oriented projects.

Project finance is the long-term financing of infrastructure and industrial projects based upon
non-recourse or limited alternative of financial structure where project debt and equity used
to finance the project are paid back from the cash flow engendered by the project.

They are most ordinarily non-recourse loans, which are fortified by the project assets and paid
entirely from project cash flow, rather than from the general assets or creditworthiness of the
project sponsors, a decision in part braced by financial modeling.

2
https://www.master-of-finance.org/faq/what-is-corporate-valuation/

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Methods of Project Financing

A survey said that 90% of respondents identified money as the greatest obstacle to
implementation of any project.

The various sources of finance can be broadly divided into two categories, viz. equity capital
and debt capital (borrowed capital). The combination of equity and debt should be judiciously
chosen, and it will vary according to the nature of the project. The project manager can choose
any one or a combination of two or more of these methods to finance the project.

1. Share capital – equity capital and preference capital.

2. Term loan
3. Debenture capital
4. Commercial banks
5. Bills discounting

Some more types of financing available are:

 Seed capital: In consonance with the Government policy which boosts a new class
of entrepreneurs and also aims wider spreading of ownership and control of manufacturing
units, a distinct scheme to complement the resource of an entrepreneur has been presented by
the Government. Assistance in this scheme is accessible in the nature of seed capital which is
generally given by way of long term interest free loan. Seed capital aid is provided to small
as well as medium scale units promoted by eligible entrepreneurs.
 Government subsidies: Subsidies drawn-out by the Central as well as State Government
form a very significant type of funds presented to a company for implementing its project.
Subsidies may be available in the nature of absolute cash grant or long-term interest free
loan. In fact, while settling the means of finance, Government subsidy forms an key source
having a vital bearing on the putting into practice of many a projects3 .

Stages in Project Financing:

3
https://en.wikipedia.org/wiki/Corporate_finance

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 Pre- finance stage
 Project identification: A Project or Projects selected should be integrated with
the Strategic Plan of the Organisation. The project plan should match the goals of the
organization. It should be realistic to be implemented.
 Identifying risk and minimizing: “The right project at the right time at the right place
and at the right price”. There should be adequate amount of resources available for the
project to be implemented.
 Technical and Financial feasibility: An organization before starting any new project or
expanding an existing one must look into analyzing each and every factor which is
essential for the project to be feasible. It must be financially as well as technically
feasible.
 Financing stage
 Arrangement of equity/debt/loan.
 Negotiation and Syndication of the same.
 Documentation and checking all the rules and regulations or policies relating to the
starting of the project.
 Payment.
 Post Financing
 Monitoring and review of project from time to time. The project manager must keep a
check on the proper working of the project.
 Project closure – It is ending the project
 Repayment and monitoring

The amount taken in the form of loan, equity and debt must be repaid back and proper
monitoring and control of the project must be carried.

Framework and Guidelines: The list of major contracts for project consist of Concession
agreement, license or mineral lease, construction contract or a development management
agreement, supply agreement, sales agreement, operating agreement, other major contracts may
occur in any specific project depending on the structure accepted.

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The borrower may have to get certain statutory and non – statutory clearances essential for the
projects like techno economic  clearance, pollution, environment and forest clearance, company
registrations, financing and land availability/ concessions etc4 .The promoter while making the
application to the financial institutions records the copies of documents most vital of which are:
i) copy of letter of allotment of plot/ sale deed in good turn of the borrower of the plot. ii)
Detailed plan of project approved by the local body. iii) Partnership deeds/ articles of association
in case of a company.

Boom of Project Financing in India : A study placed India on top in the global project
finance market in 2009, ahead of Australia, Spain and the US. The key market for project
finance in 2009 was the domestic Indian market, which rose up $30 billion (Rs 1.38 lakh crore),
accounting for 21.5 per cent of the global project finance market. This was up from $19 billion in
2008. The global project finance market was buttressed up in 2009 by government-linked
projects such as social infrastructure and renewables and by the detail that 20 per cent of the
market is in India, which poured to become the biggest and busiest market last year, knocking
down Australia from the previous year’ top position

Given the credit crunch and the collapse of major banks in the West, the global Project Finance
figures were not as strong as in the previous couple of years. According to PFI data, globally, the
Project Finance loan figure positions at $139.2 billion in 2009 compared to the overwhelming
$250 billion in 2008 and $220 billion in 2007. Totaling the figures for project bonds at $8.2
billion, down from $11.9 billion in 2008, the global Project Finance market volume stood at
$147.4 billion. That was a descent of 44 per cent from 2008, but to put it in framework, the
overall global Project Finance market set upright at $114.5 billion in 2004 and at $166 billion in
2005.

SBI settled 36 deals amounting to $20 billion of debt – 35.2 per cent of the total volume for the
Asia-Pacific region. This comprised some major contracts such as financing for the Sasan ultra
mega power project, projects of Adani Power and Sterlite Energy, and resources for Vodafone
and Unitech in the telecom sector.

4
https://www.educba.com/project-financing-in-india

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Debt and its characteristics:

Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay,
in exchange for the assets of the company. "Default risk" is the term used to describe the
likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily.
"Bond ratings" are issued on debt instruments to help investors assess the default risk of a firm.

 Debt maturity:
 Short-term debt is due in less than one year
 Long-term debt is due in more than one year
 Debt can take many forms:
 Bank overdraft
 Commercial papers
 Mortgage loans
 Bank loans
 Subordinated convertible securities
 Leases
 Convertible bond

Equity characteristics

 Ordinary shareholders:
 Are the owners of the business
 Have limited liability
 Hold an equity interest or residual claim on cash flows
 Have voting rights
 Preferred shareholders:
 Shares that take priority over ordinary shares in regards to dividends
 Right to specified dividends
 Have characteristics of both debt (fixed dividend) and equity (no final repayment date)
 Have no voting privileges

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Debt policy

The firm's debt policy is the firm's choice of mix of debt and equity financing, which is referred
to as the firm's capital structure. The prior section highlighted that this choice is not just a simple
choice between to financing sources: debt or equity. There exists several forms of debt (accounts
payable, bank debt, commercial paper, corporate bonds, etc.) and two forms of equity 5 (common
and preferred), not to mention hybrids. However, for simplicity capital structure theory deals
with which combination of the two overall sources of financing that maximizes firm value.

Does the firm's debt policy affect firm value?

The objective of the firm is to maximize shareholder value. A central question regarding the
firm's capital structure choice is therefore whether the debt policy changes firm value?

The starting point for any discussion of debt policy is the influential work by Miller and
Modigliani (MM), which states the firm's debt policy is irrelevant in perfect capital markets. In a
perfect capital market no market imperfections exists, thus, alternative capital structure theories
take into account the impact of imperfections such as taxes, cost of bankruptcy and financial
distress, transaction costs, asymmetric information and agency problems.

Debt policy in a perfect capital market

The intuition behind Miller and Modigliani's famous proposition I is that in the absence of
market imperfections it makes no difference whether the firm borrows or individual shareholders
borrow. In that case the market value of a company does not depend on its capital structure.

To assist their argument Miller and Modigliani provides the following example:

Consider two firms, firm U and firm L, that generate the same cash flow

- Firm U is all equity financed (i.e. firm U is unlevered)

- Firm L is financed by a mix of debt and equity (i.e. firm L is levered)

5
https://ebrary.net/733/business_finance/corporate_financing_valuation

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Letting D and E denote debt and equity, respectively, total value V is comprised by

- VU = EU for the unlevered Firm U

- VL = DL + EL for the levered Firm L

The financial risk is increasing in the debt-equity ratio, as the percentage spreads in returns to
shareholders are amplified: IC operating; income falls the percentage decline in the return is
larger for levered equity since the interest payment is a fixed cost the firm has to pay
independent of the operating income.

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Conclusion

Correspondingly, corporate finance comprises two main sub-disciplines. Capital budgeting is

concerned with the setting of criteria about which value-adding projects should receive
investment funding, and whether to finance that investment with equity or debt capital. 

Finally, notice that even though the expected return on equity is increasing with the financial
leverage, the expected return on assets remains constant in a perfect capital market. Intuitively,
this occurs because when the debt-equity ratio increases the relatively expensive equity is being
swapped with the cheaper debt. Mathematically the two effects (increasing expected return on
equity and the substitution of empty with debt) exactly off set each other.

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Bibliography

Books

1. Project and Infrastructure finance(corporate banking perspective) by Vikas Srivastava

2. Corporate and project finance by Edward Bodmer

Internet Sources
1. https://www.master-of-finance.org/faq/what-is-corporate-valuation/
2. https://www.master-of-finance.org/faq/what-is-corporate-valuation/
3. https://en.wikipedia.org/wiki/Corporate_finance
4. https://www.educba.com/project-financing-in-india
5. https://ebrary.net/733/business_finance/corporate_financing_valuation

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